Why portfolio rebalancing can be risky

When it comes to investing, asset allocation is the most important factor, having an influence on risk exposure and long-term performance.

Realigning the weightings of different assets such as stocks, bonds, etc. in an investment portfolio is a very tricky process. It always bears the risk of changing things for the worse. To the detriment of the risk exposure plus severely negatively impact performance.

Just think of the Standard & Poor’s Index, practically representing corporate America. A few decades ago, businesses like Amazon, Microsoft, Alphabet, Facebook, Apple represented a relatively small portion of that index. Today, these five tech companies make up roughly 20 % of the S&P.

Now, let’s assume, someone chose the S&P index a few decades ago and constantly aligned that huge stock portfolio to the original allocation of the different companies. There was a time for instance when oil supermajor ExxonMobil was one of the largest constituents in the S&P. Today, its portion has severely diminished.

The result of such a risk balancing would be that the winners like Apple, Amazon, Facebook, Alphabet, etc. were constantly cut while a constant reinvestment into the “losers” like car manufacturers, banks and oil companies happened.

At first sight, it seems, that such a rebalancing would only screw the performance because the portfolio drivers would have been “artificially” weakened. But there is another, much more severe impact.

The financial fundamentals, growth prospects, and ability to increase shareholder value over time are much more favorable with the likes of Amazon, Facebook, Alphabet, etc. compared to the “last decades losers” such as banks, car manufacturers, and big oil.

Risk includes the possibility of losing some or all of the original investment. Well, just look at the banks. It’s one thing, that their stocks have severely underperformed other sectors, but it is also very rare to find a high-quality business in that industry. The risk of dividend cuts and book losses (or stagnating stock prices over a long time period) shouldn’t be underestimated.

Most of the time, the market is the best rebalancing system for any portfolio and index.

Whenever you decide to make changes to your portfolio, be aware that these can have not only a performance impact but also on your risk exposure. Take care not to cut winners and not to pour money into losers (for instance, because they look cheap(er), because all too often, they are not).

You are responsible for your own investment and financial decisions. This article is not, and should not be regarded as investment advice or as a recommendation regarding any particular security or course of action.

About Savy Fox

SavyFox is an investment blog that writes about various interesting investment topics and shares research and opinions with respect to Stocks, Peer 2 Peer Lending, or Crypto Currency investment opportunities.

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  1. A very good piece FS! Let your winners run is something I learnt luckily enough early on in my journey. I’m not selling $MSFT, because I think they will have above average dividend growth in the years to come 👍

    I think many people look at it from an opportunity cost, and that’s where they might think they can get a better yield out there.

    • Financial Shaper

      Hi mate
      Appreciate you stopping by.
      Yes, absolutely, keeping wonderful businesses such as Microsoft, Estee Lauder, Nestlé etc. running really is crucial. Because these are the kind of companies that show fantastic fundamentals and awesome growth prospect.

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